Is Taking Out Loans to Pay Off the IRS a Good Idea?

Consider an IRS payment plan and other options.

If you’re facing a big tax bill that you can’t pay, you could be heading for IRS tax debt. And although the IRS does offer installment plans, there are other options to help with tax debt problems.

Your options include taking out a personal loan, home equity loan or using another payment method to pay your tax bill. Here’s how to weigh your options if you owe the IRS money.

How to Get a Tax Loan to Pay the IRS

If having a payment plan with the IRS and paying penalties sounds terrible, you might consider getting a personal loan to pay off your taxes. “Generally, if you can secure a personal loan for less than the IRS rate, it might be a good idea,” said Steven Repak, a certified financial planner and author of “6-Week Money Challenge for Your Personal Finances.”

If you file or e-file a tax return on time and owe money but can’t pay when you file, the IRS will charge you interest on the amount owed beginning on tax day in April. The charge will come at an interest rate equal to the federal short-term rate plus 3 percent, according to the IRS. The IRS lists the short-term, annual applicable federal rate at 1.52 percent as of December 2017.

Take a look at your credit score and what kind of personal loan interest rate you could qualify for from your bank or credit union. You might need to shop around to get the lowest rate possible. If your credit score is low, you might not be able to qualify for a personal loan rate that is better than the IRS rate.

Aaron Hatch, CFP and co-founder of Woven Capital, a fee-only financial planning and investment management firm, said that a personal loan probably isn’t the best option for most people. “Often, personal loans are unsecured debt, so the terms are unfavorable,” he said.

Check Out: 7 Best Types of Loans for People With Bad Credit

When to Choose a Home Equity Line of Credit

If you can get a lower interest rate than what the IRS will charge, it might make sense to use a home equity line of credit, said Repak. “In addition, the interest charged on your home equity loan might be tax-deductible if you itemize on your taxes, which would effectively reduce the rate of interest you are paying; the IRS interest is no longer deductible,” he said.

Keep in mind that if you default on your HELOC, the bank could foreclose on your home. Carefully weigh the pros and cons of your options and choose a method of paying the IRS that has terms you can realistically meet.

Using a Credit Card to Pay Off IRS Tax Debt

Paying off your IRS bill with a credit card will probably only make sense as a last resort because your credit card’s interest rate is likely much higher than the IRS rate, said Repak. You might, however, be able to take advantage of a promotional offer, such as 0 percent interest for a period of time with a new credit card, if you can qualify for it.

Even these 0 percent credit card promotions might charge you an upfront fee of 3 to 5 percent, Repak said, so you’ll need to compare this cost to the current IRS rate. You also need to assess how long it’ll take you to pay off your credit card balance so that you understand the full impact of this choice on your credit utilization ratio and credit history.

Why You Should Pay Off Your Tax Debt Right Away

Whether you choose a personal loan or another method of handling your tax debt, you need to file your taxes on time and pay your tax bill as soon as possible. Not doing so can cost you a lot more in the long run.

Not Filing a Tax Return Is Expensive

“If you owe money to the IRS but fail to file a return, you will incur some fairly heavy penalties,” said Repak. “In addition to charging you interest, the IRS will assess a failure-to-file penalty, which is usually 5 percent of the tax owed, per month, or part of a month that your return is late,” he said. The penalty will not exceed 25 percent of your unpaid taxes, according to the IRS.

“If your return is more than 60 days late, there is a minimum penalty for late filing, and it is the lesser of $205 or 100 percent of the tax owed, unless your failure to file was due to reasonable cause and not willful neglect,” said Repak. You can find more details on late fees and other penalties at IRS.gov under Topic 653.

“When you sign up for an IRS installment plan, the failure-to-pay penalty will decrease to one-quarter of 1 percent, and you will be charged a fee of up to $120 to set up the IRS plan,” said Repak. You’ll also have to go through an application process.

Avoid Consequences by Not Defaulting

If you default on the IRS, the IRS could seize your assets and garnish your wages, bank accounts, Social Security benefits and retirement income to start with, said Repak.

If you do get into tax debt trouble, remember that you have the right to representation, said Repak. You also have other options, such as an offer in compromise.

An OIC allows you to settle your debt with the IRS for less than the amount you owe. The IRS considers different factors before allowing this, however, such as your ability to pay and your assets. Whatever tax bracket you might be in, if you owe the IRS and can’t afford to pay your tax bill, make sure you explore all your options carefully before taking out any kind of loan.

Up Next: 9 Things You Need to Know Before Paying Your Tax Bill